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1
Future of the International Monetary and Financial Order
Central Reserve Bank of Peru
Julio VelardeGovernor
2
Outlinea. Global imbalances have not decreased significantly during the
crisis. The dollar has remained a “safe” asset.
– Global imbalances will likely continue in the medium term.– Emerging economies are greatly involved in global imbalances.
b. What are the main macroeconomic options against global imbalances?
– Currency appreciation of BRIC currencies, yen, and euro.– Increase in domestic demand outside the U.S.
c. Since global imbalances will likely not be corrected in the short term, is it possible to change the international monetary system?
d. Emerging economies, global imbalances, and the current global financial infrastructure: is there a need for change?
3
The reduction in the U.S. current account deficit does not seem to be enough to correct global imbalances.
Current account (US$ billions)
-1000
-500
0
500
1000
1500
1980 1984 1988 1992 1996 2000 2004 2008 2012
China Germany Japan United States OPECSource: IMF
4
From a historical perspective, global imbalances remain high, despite the recent correction.
Global imbalances (absolute value of current accounts as a % of GDP)
0
1
2
3
4
5
6
7
1980 1984 1988 1992 1996 2000 2004 2008 2012
Apr. 2008 Apr. 2009Source: IMF
Plaza Accord: Yen and mark appreciation
International crisis
5
Unlike the 1980s, emerging economies are greatly involved in global imbalances.
Source: IMF
Current account (as a percentage of global GDP)
-2
-1,5
-1
-0,5
0
0,5
1
1,5
1980 1984 1988 1992 1996 2000 2004 2008 2012
United States Emerging economies
6
Holdings of US Treasuries (US$ billions)
500
550
600
650
700
750
800
Jun.08
Jul Aug Sep Oct Nov Dec Jan.09
Feb Mar Apr
Holdings of US Treasuries (US$ billions)
0
50
100
150
200
250
Jun.08
Jul Aug Sep Oct Nov Dec Jan.09
Feb Mar Apr
China
Japan
UK
Lehman Brothers
Lehman Brothers
Russia
Brazil
OPECcountries
Emerging economies have built up dollar assets during the crisis.
Source: US Treasury.
7
38
21
41
0
10
20
30
40
50
60
70
BRIC and OPEC Japan Others
Foreign holding of US Treasury by countries US (as % of total foreign holdings) April 2009
63
14
23
0
10
20
30
40
50
60
70
BRIC and OPEC Japan Others
Foreign holding of US Treasury by countries US (as % of annual variation april 2008-april
2009)
Emerging economies have built up dollar assets during the crisis.
Source: US Treasury.
8
Can BW2 last longer? Similarities and differences with BW1
Similarities:• U.S. fiscal deficit is a key driver of external deficit (twin deficits).• Capital controls in countries with high intervention in FX markets.
Differences:• New Bretton Woods regime is not global. Eurozone allows its
currency to float and the euro has faced excessive pressures.
• BW1 was the result of an explicit institutional arrangement. BW2is an implicit one (therefore more fragile).
• The current financial crisis stopped the expected adjustment:currency appreciation of Asian currencies is less likely now because of declining inflationary pressures, lower external demand, and high risk aversion.
9
Correction of global imbalances: some mechanisms
Higher consumption in China:
• Difficulties in changing growth pattern (from outward to inward oriented) in the short term.
• Consumption in China is seven times lower than in the U.S.
Higher growth in surplus countries (Germany and Japan):
• In the short term, consumption and investment will remain constrained.
• Edwards (2007): Impact of higher growth in Europe and Japan will improve U.S. external balance modestly.
10
Since global imbalances will likely not be corrected in the short term, how feasible is a change in the international monetary system?
• Replacement of the dollar with another strong currency.
• Greater role for BRIC currencies.
• Issuance of non-dollar assets (SDR-denominated bonds).
11
Replacing the dollar with another strong currency?
• The introduction of the euro has not yet resulted in a significant change in the currency composition of official reserve holdings.
• The U.S. dollar has maintained its place as the dominant reserve currency, supported perhaps by the edge that dollar financial markets still have over euro markets in terms of size, credit quality and liquidity, as well as inertia in the use of international currencies.
*Galati and Wooldridge (2008) Theeuro as a reserve currency: a challenge to the pre-eminence of the US dollar?
12
• Relatively more optimistic growth expectations in the U.S. (more flexible markets and higher productivity).
• However, in terms of global output, the euro should play an increasing role in line with Eurozone enlargement.
GDP (share on global output)
10
1214
16
1820
22
2426
28
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
Eurozone European Union USA
European Union
USA
Eurozone
Replacing the dollar with another strong currency?
Source: IMF
13
• Risk of exchange rate losses in countries with high dollar holdings (BRICs and other emerging economies). However, the current accumulation of U.S. dollars can magnify future losses.
• The euro improved the functioning of European financial markets.Even though the liquidity and breadth of euro financial markets are fast approaching those of dollar markets, banking and capital markets in the euro area remain segmented.
• U.S. governance (federal system) differs from the Eurozone. The European single currency is governed by a single monetary policy, but leaves fiscal policy with member states.
Galati and Wooldridge (2008). The euro as a reserve currency: a challenge to thepre-eminence of the U.S. dollar?
Replacing the dollar with another strong currency?
14
The BRIC economies, greatly involved in global imbalances,could reduce the share of dollar assets only gradually. A sharp shift does not seem possible in the short run.
China's foreign assets
USD others
8%
Non USD assets35%
US Agency
23%US
Treasury34%
Few alternatives to dollar assets in theshort term:
•Shortage of safe assets.•Other government bonds not soliquid.•Gold market relatively smallcompared to China’s assets: 5% of its reserves equals one year of world gold production.
“Dollar trap”:•Risk of exchange rate losses.•Lower demand from U.S.
Source: UBS
15
Dollar versus Euro in Trade transactions
a. Exports of homogeneous primary goods (commodities) tend to be tradedin dollars with worldwide formation in a centralized exchange.
b. Export of manufactured goods tend to be in the home industrializedcurrencies.
• Before the establishment of the Euro Area, more than 75 percent ofGerman export were invoiced in marks and more than 50 percent ofFrench export were invoiced in francs. Nowadays, continental Europeancountries invoice their net exports outside the European Union mainly in euros.
• Japan only invoiced about 36 percent of its exports in its own currencybecause the U.S. is its main export market.
Mc. Kinnon. Euroland and East Asia in a Dollar-Based International Monetary System
16Source: BIS
Source: BIS
18
1. The dollar took over as dominant reserve currency in the mid-1920s, four decades after the U.S. became the world’s main industrial economy.
2. There is room for more than one dominant reserve currency:The dollar and sterling shared dominance during most of the inter-war period (more than 97% of world international reserves together).
Investors pooled risks by placing reserves in London and New York, both deep and liquid financial centers.
The dollar-sterling duopoly replaced the previous sterling-franc-mark oligopoly. Therefore the real anomaly is the dominance of one currency.
Eichengreen & Flandreau (2008). The Rise and Fall of the Dollar, or When did the Dollar Replace Sterling as the Leading Reserve Currency?
Replacing the dollar with another strong currency?
19
Conditions for a replacement of the dollar by the euro in the medium term.
Frankel and Chin (2009). Will the euro eventually surpass the dollar as leading international reserve currency?
• The major pay-off of the paper is predictions about scenarios under which the euro might in the future rival or surpass the dollar as the world’s leading international reserve currency. That question appears to depend most importantly on two things:1. Whether enough other EU members join euroland so that it becomes larger than
the U.S. economy and, in particular, whether the UK comes in, with its large financial markets.
2. Whether U.S. macroeconomic policies eventually undermine confidence in the value of the dollar through inflation and depreciation. Whatever value this exercise has probably consists of estimating, contingent on those two things happening, how quickly the euro might rise to challenge the dollar.
• We find that if all 13 EU members who are not currently in EMU join it by 2020, including the United Kingdom, then the euro overtakes the dollar a few years later. We also find that even if some of these countries do not join, a continuation of the recent trend depreciation of the dollar, were it to occur for whatever reason, could bring about the tipping point even sooner.
20
Greater role for BRIC currencies?
Source: UBS
21
1. Several capital controls on BRIC currencies.
2. Limited scope as tradable currencies:
• Trade between BRICs and other emerging economies still lower than with developed economies.
• Developed economies account for more than 50 percent of exports from China.
Greater role for BRIC currencies? Some limitations.
Exports by Region, 2007Percentage Share
North America
S/C America Europe ÁfricaMiddle East
CISAsia, exc. Japan
Japan
Brazil 20% 24% 27% 6% 4% 3% 13% 4%Russia 4% 1% 60% 1% 2% 15% 13% 3%India 15% 3% 23% 9% 17% 1% 29% 3%China 22% 3% 22% 3% 4% 4% 32% 11%Source: International Trade Statistics 2008, WTO
Greater role for BRIC currencies: Some limitations
22
23
Scale of RMB business in the financial system still low, but increasing.
• In recent months, the Chinese mainland has completed bilateral currency swap deals with several countries:- Korea (CNY 180bn, December 2008)- Hong Kong (CNY 200bn, January 2009)- Malaysia (CNY 80bn, February 2009)- Belarus (CNY 20 bn, March 2009)- Indonesia (CNY 100bn, March 2009)- Argentina (CNY 70bn, March 2009)
• April 2009: a scheme of allowing settlement in CNY in the trade of Shanghai, Shenzhen, Guangzhou, Zhuhai, and Dongguan with Hong Kong and Macau, and in the trade of Yunnan and Guangxi with South East Asian Nations.
• June 2009: Malaysia’s Central Bank is allowed to purchase and hold Chinese government debt as part of its foreign reserves and as possible hedge against the weakening of the U.S. dollar.
24
An alternative asset ( SDR denominated bonds) would ultimately rely on the U.S. dollar.
Source: IMF
25
SDR volatility.
Source: Bloomberg
BRICs economies has a lower share in the IMF than in the world economy
26Emerging economies could surpass the advanced economies as early as 2014in terms of their share of world GDP.
IFIs’ response to the crisis
• Access limits raised significantly.• Additional bilateral financing.• Increase in lending capacity for low- income countries.• Proposed general SDR allocation to enhance
international liquidity.• A new credit line (FCL) for countries with strong
fundamentals.• Proposed capital increases in regional development
banks.• Actions to leverage private capital.• Support to trade liquidity.
27
IFIs’ response to the crisis
Four key areas where global architecture needs to be enhanced:
•Surveillance: (i) follow-up of global economic developments and policies; (ii) early warning mechanism and specific policy response.
•Multilateral coordination: (i) coordination of macroeconomic policies across governments; (ii) rebalancing of quotas in multilateral agencies.
•Regulation and supervision of internationally active financial institutions.
•Arrangements to ensure adequate international liquidity; loans to support adjustment.
28
29
Future of the International Monetary and Financial Order
Central Reserve Bank of Peru
Julio VelardeGovernor